Basic Accounting and Indicators for Entrepreneurs

Posted by mjmedlock on April 29, 2019 in business startups |

Accounts tell us about the health of our company. Forecast account help us understand what we need to do to remain healthy in the future.

For a start-up business the most important financial document is the cash flow forecast. This does not mean that the profit and loss statement (a.k.a. income statement) and the balance sheet aren’t important. Of course your business needs to be profitable at some point in the future, and of course the firm needs to build a strong balance sheet in order to obtain loans and help investors value the company. However, in the early stages cash is the biggest issue facing a new business. If you run out of cash, it’s like running out of oxygen: your business will die, even if it has great profit potential.

Example Pro Forma Cash Flow Forecast

  Jan Feb March April May June
12.0 27.2 41.6 61.2 82.0 96.0
Cost of goods 8.0 14.8 22.4 37.6 43.0 49.0
Salaries 23.2 23.2 26.2 26.2 26.2 26.2
Rent 2.0 2.0 2.0 2.0 2.0 2.0
Utilities 0.9 0.9 0.9 0.8 0.8 0.8
Advertising 13.5 13.5 17.0 17.0 17.0 17.0
Sales costs 1.0 1.0 1.0 1.0 1.0 1.0
Insurance 2.0 2.0 2.0 2.0 2.0 2.0
Social taxes 2.1 2.1 2.5 2.5 2.5 2.5
Office expenses 1.5 1.5 1.5 1.7 1.8 2.0
Inventory 0.2 0.4 0.6 0.6 0.8 0.8
Total costs 126.4 61.4 76.1 91.4 97.1 103.3
Cash flow (114.4) (34.2) (34.5) (30.2) (15.1) (7.3)
Opening balance 300.0 185.6 151.4 116.9 86.7 71.6
Ending Balance 185.6 151.4 116.9 86.7 71.6 64.3

The business should pay particular attention to the “burn rate”, or how quickly the enterprise is spending its cash reserves. This will indicate the length of your “runway”, or the amount to time your business has before it runs out of cash.

Break-even Analysis

What level of sales turnover is your business going to need to become profitable? Is this level realistic? How long will it take you to achieve this level? What might stop your business achieving break-even?

Here are some ways of calculating your break-even point:

Unit contribution

Contribution margin

This is a two-step process.

Break-even profit goals

You can also use break-even formulae to calculate how much you need to sell to reach a particular profit goal.

This will give us an answer in unit sales. If we want to know the volume of dollar sales, and we do, we simply multiply units by price.

Or alternatively using the contribution margin method.

Profit and loss and balance sheet

If you have come this far in a business studies degree, you will not need me to explain how to create a profit and loss statement or a balance sheet. (I hope not anyway!) The only thing I would like to point out at this stage is that P&L and your P&L forecasts should be compiled monthly. This is good practice anyway, but it is especially important in a start-up situation. You need to know what is changing in your business, and why. Any investors need to understand the sales and profit story so far and where it is expected to be over the next three to five years.

Key Performance Indicators (KPIs)

Accounting information often does not tell us enough about why a business is thriving or failing. Other performance indicators are needed. A business will need to identify what drives sales and profit. Some of these can be quite obvious, such as the number of new customers acquired each month. Others might seem to drive the business forward, but in reality have no bearing on sales and profitability. Examples of such “vanity metrics” might be: visitors to a website, but no sales; apps downloaded, but not used so they don’t generate advertising revenue; sales visits to prospects, but no new business. The list could go on. The important thing to do then is to identify the activities the drive your business forward, and then find a way to measure them.

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